Bankers sound alarm on loans

John Greenwood, Financial Post · Thursday, Dec. 9, 2010

Some of Canada’s top bank executives are growing increasingly uncomfortable with the level of debt Canadians are taking on through long-amortization mortgages.

“I think all of us are looking at [what to do],” said Ed Clark, chief executive of Toronto-Dominion Bank, adding the current situation “is not a good thing.”Speaking in an interview, Mr. Clark said TD has already acted to slow lending but it’s now up to the federal government to take steps such as reducing maximum amortization periods on home loans to 25 years from 35 years or lowering loan-to-value ratios.“These are exactly the things that government should be doing and there’s been a lot of discussion,” he said. Bank of Montreal CEO Bill Downe said his organization is also doing what it can to rein in customer borrowing, but fixing the problem without hurting the economy is “the challenge for Canada.”

“I think [tighter mortgage rules] is consistent with maintaining healthy consumer debt levels,” he said, suggesting the changes could be included in the next federal budget.

Meanwhile, the Bank of Canada is again raising the alarm about the perilous state of household finances. In the December issue of the Financial System Review released Thursday, it singled out elevated consumer debt as a “key risk” for the Canadian economy.

Fuelled by rock-bottom interest rates and a rising real estate market, Canadians have been borrowing at a rate much faster than their income has grown — especially over the last two years — raising concern that they are becoming vulnerable to economic shocks such as rising unemployment and stagnant wages.

For the first time, the value of mortgages outstanding — the biggest chunk of consumer debt — recently topped $1-trillion, according to Bank of Canada statistics.

A spokesman for Canadian Bankers Association declined to comment on whether it is lobbying the government for tougher regulations.

“Banks have contributed with their own economic research to the ongoing public discussion about household borrowing and debt levels in Canada, and there is broad agreement that this is a matter that merits close attention,” said Terry Campbell, vice-president of policy at the Canadian Bankers Association.

The banks first approached Ottawa asking for tighter lending rules at the start of the year. In February, Finance Minister Jim Flaherty gave them what they wanted, unveiling a list of changes to mortgage rules, including a requirement forcing all homebuyers to meet the standards for a five-year, fixed-rate loan even if they chose a variable mortgage with a shorter term. There were also rules lowering the maximum amount consumers could borrow against their homes to 90% from 95%.

The trouble was consumers barely noticed as the spending spree went on largely unabated. According Moody’s Investors Service Inc., household debt levels relative to income are following a similar trajectory as in the United States during the credit bubble.

Bank officials argue it’s unfair to compare the two countries because mortgage lending standards have always been much tougher in this country and there was never a major subprime mortgage sector.

Nevertheless, requirements did get loosened in the bubble years when the government allowed the amortization period on mortgages rise to 40 years.

“Originally, we said moving from 25 years to 40 years was a mistake,” Mr. Clark said. “We didn’t think it was a good idea. [When the crisis hit] the government moved back from 40 to 35 and I think from a public policy view, over the long run, it would better to get back to 25.”

He said it’s the responsibility of the government and not the banks to tighten the rules because it’s the government that regulates the market.

“If CMHC policy is 35-year [amortization], not 25 years it’s very hard for the industry to say, OK, let’s move to 25 years,” Mr. Clark said.

For his part, Mr. Downe said, he’s not trying to tell the Department of Finance what to do.

“I’m not prescriptive but I think those kinds of ideas [such as shortening amortizations] resonate,” he said in an interview earlier this week.

Moving to shorter amortizations would likely have a significant impact on the market. Statistics Canada finds 42% of all new mortgages are for amortization periods of more than 25 years.

Making a return on your mortgage

ROB CARRICK
Taken from the Globe and Mail
Published Friday, Nov. 26, 2010 3:47PM EST

The 5-per-cent return on safe investments is back.

It happened last week when major banks increased their posted mortgage rates. If you were lending money out for mortgages like a bank, you could get the same return.

Here’s how: Just use the money in your registered retirement savings plan to finance your mortgage.

Mortgage negotiations Investing your RRSP dollars in your mortgage is a fringe strategy – let’s get that straight. Several financial institutions offer it, but not with much enthusiasm. It’s costly and time consuming to set up, and it locks you into returns that could be lower than what a diversified investment portfolio could earn over the long term. If your entire RRSP is invested in your mortgage, then there’s also a lack of diversification to worry about.

And yet, there’s a steady level of interest in this strategy. Mike Wise, a Calgary investment adviser, said most of the inquiries he gets are from people who want to use RRSP money as a source of funds to buy investment real estate. These people are often stretched financially and may not qualify for traditional mortgages.

The other group interested in the mortgage-RRSP strategy is made up of conservative investors who see their mortgage as a potential replacement for the low-yielding bonds and term deposits they own.

“That kind of person would be a jewel for this strategy,” said Mr. Wise, who 11 years ago put his own mortgage in his RRSP and wrote about it for Canadian MoneySaver magazine (read it here).

Charley Tsai, vice-president of wealth planning support at TD Waterhouse, offers this guideline on deciding whether it makes sense to hold your mortgage in your RRSP: “It’s worthwhile if the mortgage interest rate, net of expenses, would be greater than the investment return you would generate from your RRSP.”

Let’s deal with the “net of expenses” side of things first. Prepare yourself for a fee-for-all if you set up what banks call a non-arm’s length mortgage.

Start with the mortgage set-up fee and annual mortgage administration fee, which at TD are $250 and $225, respectively. Next, there are legal fees that can cost, in one mortgage broker’s estimation, anywhere from $500 to $1,000, depending on the specifics.

Now add mortgage insurance fees that will apply regardless of how much equity you have in your home. Genworth Financial, a private provider of mortgage insurance in Canada, says the insurance premium on mortgage amounts ranging as high as 65 per cent of the value of a home will be 0.5 per cent of the amount borrowed. Premiums rise as high as 2.75 per cent for mortgages that are up to 95 per cent of a home’s value.

You could face still another fee if you break an existing mortgage so you can move it into your RRSP. For that reason, the best time to adopt this strategy is when your mortgage comes up for renewal.

Negotiating the mortgage

When negotiating a typical mortgage, your goal should be to hammer the rate down as far as it will go. Just the opposite applies with an RRSP mortgage, because you are essentially paying interest to yourself, not the bank.

“If you’re doing this, you want to try and have as high an interest rate as possible,” Mr. Tsai said.

TD rules say you have to go with the posted mortgage rate for a non-arm’s length mortgage, but there’s still some manoeuvring room to bump up your rate high enough to make it an attractive investment for your RRSP.

Mr. Tsai said TD will allow you to select mortgage terms of one through 10 years. A five-year fixed rate would have put you at 5.44 per cent as of late this week; extending to six years put you at 5.7 per cent, seven years was at 6.09 per cent and 10 years was pegged at 6.4 per cent.

TD also allows a six-month convertible mortgage, which presents an interesting possibility if you see rates moving higher. You’d get a 4.45-per-cent rate for half a year, with an opportunity to benefit from any rate increases that happen between now and then.

But is it a wise investment?

Now to the question of whether it makes sense to put your mortgage in your RRSP from an investment point of view. If we take all the startup fees mentioned above, we end up with a cost of roughly $1,000 to $2,000 in the first year, assuming a $100,000 mortgage. Essentially, you could have a first-year fee of up to 2 per cent if you decide to pay your mortgage insurance upfront.

The cost looks more attractive in subsequent years, when the $225 annual admin fee works out to a fee of just 0.23 per cent.

These fees tell us that conservative investors earning 2 to 3 per cent in their retirement savings should not find it hard to get a better return from the mortgage-RRSP strategy.

“If you have fixed income in your RRSP and if it’s generating a very low yield, then this may be something worth looking at,” Mr. Tsai said. “The greater the difference, the more economic sense it might make to do this.”

Mr. Wise, the Calgary investment adviser, said the mortgage-RRSP strategy works best if you use the mortgage to replace the bonds and GICs in your portfolio while leaving your holdings in the stock market.

If putting your mortgage in your RRSP leaves you light on equities, take the mortgage payments flowing into your retirement plan and invest them in stocks, funds and so forth. In fact, investing each successive mortgage payment gives you a nice little dollar-cost averaging program.

Making mortgage payments into your retirement plan does not affect your RRSP contribution room. So you can further diversify your retirement savings using the money you annually add to your RRSP, separate from your mortgage.

One of the challenges in putting your mortgage in your RRSP is to find a trustee for the plan. In addition to TD Waterhouse, the online brokerages CIBC Investor’s Edge, RBC Direct Investing, Scotia iTrade and ScotiaMcLeod Direct Investing all allow this. Bank of Montreal says it no longer offers this program. If you have an investment adviser, he or she should be able to find a trust company to hold your mortgage RRSP.

Don’t forget the usual strategizing if you’re putting your mortgage into your RRSP – amortization period, biweekly versus monthly payments and so on. An interesting question arises here: Do you put the priority here on getting your mortgage paid off as quickly as possible, or on building your RRSP?

“If I can get a fixed income investment in my RRSP that will give me 5 per cent, I think I’d want to keep that as long as possible,” Mr. Wise said.

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HOW TO DO IT

Investing your registered retirement savings plan in the mortgage on your home is not for everyone, but it can generate steady returns that beat what bonds and term deposits offer.

Step One

Find a bank, investment dealer, trust company that offers this service; some investment advisers may also be able to help you set this up.

Step Two

Tally up fees – expect to pay a set-up fee, an annual mortgage administration fee, legal fees to set up the RRSP mortgage, mortgage insurance fees and possibly discharge fees if you're breaking your current mortgage.

Step Three

Pick mortgage terms. Expect rules guiding the rate you can use, the mortgage terms available and so forth.

Step Four

Use the money you're paying into your RRSP to diversify your RRSP investments, possibly by making regular purchases of stocks or equity funds and ETFs

WHAT YOU SHOULD KNOW

Four things to keep in mind about investing your retirement savings in your mortgage:

1. You can invest RRIF money in your mortgage, but you must have enough cash on hand to fund the required minimum annual RRIF withdrawal.

2. Some banks will allow you to use RRSP money to buy a residential investment property, while others allow this only for an owner-occupied residence.

3. It may be possible to invest in a mortgage on someone else's property.

4. You'll need mortgage default insurance even though you're lending to yourself and even if you have a lot of equity in your home.

Homeowners unfazed by long amortization

'People will always decide what's easiest for them'

By Garry Marr, Financial Post November 10, 2010

Canadians plan to take longer to pay off their mortgages but they don't expect it to affect their retirement plans. Something just doesn't add up.

A new study from the Canadian Association of Accredited Mortgage Professionals shows consumers are taking advantage of longer amortization lengths at previously unheard of levels. Statistics released this week show 42% of new mortgages in the last year went for an amortization period of more than 25 years.

It's a huge jump when you consider that just five years ago, you couldn't even get an insured mortgage backed by the government that was amortized for more than 25 years.

The reason for the longer amortization periods is simple -- you can qualify for more mortgage when your monthly payment is lower because it is spread out over 35 years instead of 25 years.

Within the same survey by CAAMP, consumers were asked about their retirement expectations. Those with extended amortizations plan to retire on average at 61.9 years. Those amortizing their mortgage for less than 25 years plan to retire on average at 61.5 years.

"This data on expectations does not prove that actual retirement will be unaffected by recent trends in housing and mortgage markets," says CAAMP in its study. no kidding.

"But it does suggest that consumers' evaluations of their life-cycle options have not been materially altered."

Are consumers being entirely realistic about their future?

Will Dunning, chief economist with CAAMP, says the percentage of Canadians retiring with a mortgage is small enough that it is difficult to track.

"We find a lot of people taking [longer amortizations] are making additional payments," says Mr. Dunning, adding previous studies have shown people "aggressively" try to repay their mortgages.

Victor Fiume, president of the Canadian Home Builders' Association, says Canada is just catching up to a trend that has taken place in other jurisdictions.

"In many, many countries across the world, paying off a home is a multi-generational kind of thing. It doesn't happen in this generation. A lot of the stuff that goes on in England is multi-generational because the houses are so expensive," says Mr. Fiume.

There is no arguing the increased flexibility a longer amortization mortgage gives you, but increasingly some consumers do find themselves getting into financial trouble because they have bitten off too much mortgage, says Patricia White, executive director of Credit Counselling Canada.

"People will always decide what is easiest for them," she says. "But you have to plan in advance to make accelerated payments. You need to make some conscious decisions about how to get rid of that mortgage debt faster."

Canadians always do better when they have direct withdrawals from their bank accounts and less discretionary power about paying down debt, adds Ms. White.

Vince Gaetano, a principal broker and owner at Monster Mortgage, agrees people who choose the longer amortization and the lower payment rarely take advantage of that extra cash flow to make additional payments later on. "It's a very small group of people who do that," he says.

He thinks consumers going for the longer amortization are banking on their homes rising in value faster than any gains they get paying their mortgage off earlier.

"Real estate over time will appreciate at more than 2% to 4% per year," says Mr. Gaetano.

"People are saying, 'It won't affect my retirement because I plan to retire with a home that will appreciate in value in addition to the amount I pay it down.' It's not a bad strategy if you are in a market that gives you consistent appreciation, but you are not going to get that in every market in Canada."

But there is no getting around the fact the people who take a longer amortization will take longer to repay their loan.

The CAAMP study found consumers going longer than 25 years, were done with their mortgage at age 53 on average, compared with an average of 47 years for those going less than 25 years.

If you are going for a longer amortization, you better hope your home goes up in value because you are going to have fewer mortgage-free years in which to save. It's hard to believe that won't affect retirement plans.

gmarr@nationalpost.com